Guide to offshore bonds

Guide to offshore bonds

Compliance / Factsheet

This document highlights the key areas for consideration when advising on offshore
bonds. It is designed to help you explain the main advantages and disadvantages of using
these products within your suitability reports.

Careful tax planning should form the basis of any financial review and investing offshore is one way in which tax
efficiency can be maximised. However, it must not be viewed as a way in which investors can shelter money away from
tax. It must be remembered that tax is merely ‘deferred’.

For the vast majority of ‘mainstream’ clients, a traditional UK based product is likely to be most attractive. In particular,
before settling on a bond (whether onshore or offshore) the following should be considered:

––ISAs provide a tax efficient option for private investors of all kinds. This, combined with the diversity of ISA fund types,
means their suitability is exceptionally broad and are always likely to be the first consideration for a client’s investments
––Clients who don’t use their capital gains tax allowance are likely to find that tax treatment of collective investments
favourable. For these individuals, funds that provide mainly, or only growth will be particularly advantageous.

Potentially suitable circumstances

Offshore bonds can be useful in a number of circumstances. We have outlined some of these below:

Wealthy clients
Offshore bonds can be very useful for wealthy clients who have already exhausted other tax efficient savings vehicles,
such as pension allowances and ISA allowances. This could be because on encashment:

––Some higher rate taxpayers may expect to pay a lower rate of tax in the future, at a time when they plan to take the
proceeds from their investment.
––There is the option to assign the bond to another individual who pays a lower rate of tax (or no tax) to help to reduce
the overall liability.

University fees planning

As part of university fees planning, wealthy parents can invest tax efficiently into an offshore bond and assign this to
their child when they go to university. As students do not usually pay tax, no tax will be payable in most instances.
Offshore bonds are often overlooked for this specific objective.

Clients spending time overseas

An offshore bond may also be beneficial to clients that are likely to be resident abroad for some of the investment
period, as the UK tax regime allows the years of non- residence to be excluded for tax calculation purposes.

Furthermore, using funds with ‘non distributor’ status allows foreign nationals to hold their worldwide investments in
a way that does not generate annual income or an IHT liability, enabling them to have some flexibility and control over
the timing and amount of any tax charge charged. The annual 5% tax deferred withdrawal of capital facility also does
not count as ‘income’ for these individuals.

Clients retiring abroad

For those who are planning to live or retire abroad, consideration must be given to the country in which they are
planning to move. Whilst UK tax may be avoided on policy gains, local tax may be applied.

Unlike the UK, most foreign countries tax life policy gains irrespective of whether the policy gains are ‘rolled up’ gross or
are in a taxed fund. It is therefore important not to put too much emphasis on future plans without definitive evidence
showing the actual likely advantages to the client.

This can be done by checking with a specialist tax professional in the UK, or an overseas tax adviser in the other
jurisdiction. It is not enough simply to state that you have not given advice on the tax treatment of the plan in the other

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jurisdiction, as it is then extremely difficult to demonstrate suitability. Prohibitive tax treatment in the other jurisdiction
Compliance / Factsheet

could make a seemingly suitable plan unsuitable.

Onshore v offshore comparisons

All other things being equal, the compounding effect within an offshore bond (given that tax is not regularly deducted)
should result in greater growth. But the advantages of ‘gross roll up’ gains on offshore bonds can be more illusory than
truly beneficial. There are several factors that reduce (or can quite easily cancel out) these advantages, as described
below.

It is worth noting that offshore bonds are likely to use higher projection rates to reflect the absence of tax paid within
the fund. But it is the post tax situation that will determine the most beneficial outcome for the client.

Gross/net gain

This is an important consideration where the client is likely to remain within the higher/additional rate tax bands on
encashment.

For higher/additional rate taxpayers, the extra tax payable on gains made from onshore bonds applies to the net gain
(after the deemed 20% tax paid within the fund is taken into account) whereas, on gains made from offshore bonds,
tax is paid on the gross gain. For example, if a higher rate taxpayer receives a net gain of £100,000 from an onshore
bond:

––20% tax is deemed paid, therefore making the total gain £125,000
––Additional tax of 20% applies to the £100,000 received;
––Therefore, total tax paid is £45,000 (£25,000 + £20,000)

With an offshore bond, using the same client scenario:

––Client would receive £125,000 gross

––Client would be taxed at 40% on this - £50,000 tax due

For higher rate taxpayers, the effective rate applied to investment bond gains is 36%, as opposed to 40% applied to
offshore bonds.

Effects of withholding tax

Offshore jurisdictions can impose a withholding tax on income generated within the fund. The purpose of the
withholding tax is to collect tax at source in circumstances where it might otherwise be difficult to collect, as well as to
combat tax evasion.

The amount deducted depends on the jurisdiction in which the bond is based. Also, jurisdictions tend to vary the
amount withheld according to the underlying assets, for example, different rates may apply to both interest and
dividend income.

Withholding tax can have the effect of reducing the tax advantages and in some circumstances it can introduce an
element of ‘double taxation’. So you should not refer to the bond’s funds as ‘tax-free’ if withholding tax is being
applied.

Given the various rates of withholding tax applied by different jurisdictions; and the ways in which these interact with
double taxation agreements held with HMRC, the situation as regards withholding tax can be complex.

When recommending an offshore bond, you should ensure that your client fully understands how this might
affect them and how they might potentially offset withheld tax against their UK tax liability, where double taxation
agreements are in place. You should outline this in your suitability report.

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Compliance / Factsheet

Product charges

 In addition to the differences in taxation, product charges should also be a main consideration when deciding whether
or not to recommend an offshore bond.

The charges on offshore bonds are generally more expensive than onshore investments. This is because, unlike onshore
bonds, the expenses within offshore funds cannot be offset against the taxation, as there is no internal tax to offset
them against.

In addition, the costs associated with running an offshore fund can be a lot higher than running an onshore fund.
Because of this, benefits of gross roll up are reduced (and could quite possibly be cancelled out) for those offshore plans
that carry higher charges.

Reduction in yield figures can offer a reasonable comparison of charges for both onshore and offshore bonds, but you
must remember that such a comparison is of little use if the tax position has not been fully considered. The combination
of likely tax and product charges is ultimately going to determine whether or not an offshore bond will be the most
beneficial contract for the client.

Investment horizon

Given the effects of the (generally) higher charges associated with offshore bonds, gross roll up is only likely to be
beneficial to the client over very long periods of time. Because of this, where the investment is for a relatively short
term, it is likely that an offshore bond will be less appropriate than its onshore alternative.

The term of the investment is therefore fundamental to suitability of the type of product selected.

Available tax relief

The main tax relief associated with both onshore and offshore bonds is top-slicing relief. Offshore bonds also benefit
from time apportionment relief. Both of these reliefs are explained below.

Top Slicing Relief

When a chargeable event occurs, top slicing relief can be available to basic rate taxpayers to help reduce any additional
tax that may be payable. In simple terms, the relief is given as follows:

––The gain is divided by the number of full policy years that the plan has been in force. The resultant ‘slice’ is then added
to other income. If any part of this ‘slice’ falls within the individual’s higher rate tax band, then higher rate tax will be
due.
––The amount of higher rate tax payable will be the amount of the ‘slice’ that falls within the higher rate tax band
multiplied by the number of full years that the policy has been in force (unless there are periods of non-residence. See
below)

For offshore bonds, top slicing will apply to the full life of the policy since inception, whereas for onshore bonds, top
slicing is calculated from the period since the last chargeable gain occurred.

Because of this, using an offshore bond can put the investor at an advantage in some circumstances, i.e. where they are
likely to make partial withdrawals over and above the (cumulative) 5% tax deferred withdrawals allowance.

Time apportionment relief

Potential liability to tax can further be reduced by the application of time apportionment relief. This relief applies if
a client has been non-UK resident at any time during the lifetime of the bond. As with top slicing relief, it works by
reducing the amount of the overall gain that is subject to tax. The formula for calculating time apportionment relief is as
follows:

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Compliance / Factsheet

Period of ownership as UK resident multiplied by gain ÷ period policy has been in force.

(NB: This may not apply to some policies held in trust)

You should also remember that, where both time apportionment relief and top-slicing relief apply, the number of years
used for the top-slicing calculation will be reduced by the number of full years the client has spent outside of the UK.

Investor Protection

The compensation and investor protection situation for offshore bonds can be complicated. Some contracts may be
covered by the FSCS but otherwise, compensation and regulatory protection in the bond’s country of domicile can be
extremely limited and may not exist in some cases. This will need to be investigated as part of your overall assessment of
suitability.

For further information on how regulatory protections that apply to offshore bonds, please refer to:

––Section 4.of the ‘Guide to compensation;’ and

––‘Offshore bonds’ section of ‘How to assess suitability when advising on investments’ guide

You can download the Guide to compensation from sesame.co.uk > research>document library

You can download the How to guide from sesame.co.uk > compliance > Investment business>how to guides

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